Big Bank Collision Course
Different arms of Government are driving change in UK banks whose co-incidence in time looks very hard for banks to handle;
• Her Majesty’s Treasury and the Finance Select Committee are driving Ring Fencing changes in banks, due for completion by 31/12/2018.
• The Department for Business is pushing changes to the cheque clearing systems under its “future clearing” programme due for completion by October 2017 (although all indications are that the required implementation date will be delayed).
• The European Authorities, not to be left out, are forcing through Payment Services Directive 2 (aka PSDII), the main elements of which are due for implementation by 13/01/2018.
In the opinion of HBW, there is too much change to “critical hotspots” in the big UK banks for these programmes to be able to be delivered. The rest of this article explores this hypothesis in four sections!
• An overview of the relevant ICB Ring Fencing impacts on UK banks.
• An overview of the relevant Future Clearing impacts on UK banks.
• An overview of the relevant PSDII impacts on UK banks.
• A conclusion on the combined impact on IT and Operations.
Overview Of ICB Ring Fencing
This section does not describe all the changes associated with ICB Ring Fencing, rather those relevant to UK banks’ Core IT and operations. First of all, it has to be made clear that ICB Ring Fencing only applies to banks with more than £25bn of deposits in the UK. Thus, at the minute, this realistically only applies to Barclays, HSBC, Lloyds, RBS and Santander UK.
The aim is to Ring Fence those activities that are critical to the UK economy into a “relatively separate” bank within the banking group. Importantly all retail and small business deposits and current accounts must be in the Ring Fenced Bank (RFB) as well as UK payments systems support (BACS, Faster Payments, CHAPS, Cards, ATM’s) for these customer groups.
Conversely, banking activities outside EEA and proprietary trading must not take place in the RFB; so as to reduce the riskiness of activities in the RFB and reduce the risk of contagion from the financial failures of other banks/countries.
In general all five of the big UK banks had a high degree of integration of operations and IT across geographies and customer segments which means that all of them have to create major change programmes to enable the required separation of activities in their systems and group level entity structures. In particular some of the key changes they are wrestling with for the purposes of this article are;
• Moving customers between legal entities, in whole or in part so as to comply with Ring Fencing rules. This has knock on into changes of sort code and account number for customers and associated payment re-routing changes.
• Ensuring Payment Scheme ownership, liquidity and settlement are all aligned with the RFB and not mixed up with NRFB versions of the same concepts. This will often result in complex changes to “Intra Group” Agency Banking and settlement arrangements in core accounting and payment systems.
• Credit Management Processes for mid and large corporate are likely to be changed as these customers are most likely to have propositions sold from both the RFB and NRFB. For example, a midsized corporate is very likely to have current accounts with overdrafts in the RFB so as to be able to access the UK domestic payment systems but will very likely want derivatives sold by the Non Ring Fenced Bank. Managing credit and collateral across the Ring Fence will require policy, process and systems changes. Also new processes will be required to divide income for such customers on an “arm’s length” commercial arrangement basis.
• Most banks will want to continue to have integrated operations and systems across the Group for economy of scale reasons. This is permitted but requires a shared service to be put in place to change the RFB and NRFB on the basis of commercial “arm’s length” arrangements. This will drive new industrial strength, transparent billing and charging processes for shared services such as Payments, IT and Core Banking.
All of these changes become legally enforced from 31/12/2018 but most banks will want to have implemented them at least six months beforehand to demonstrate compliant running prior to that date.
Overview Of Future Clearing
The Future Clearing Project affects all banks that handle UK cheques, not just the big UK clearing banks but also the smaller banks that rely on the big banks for cheque clearing services. The five banks affected by ICB process over 80% of all the paper cheque and debits in the UK and so are crucial to the success of this initiative.
The idea of Future Clearing is change from a system of physical exchange of paper cheques and credits to one involving the interchange of electronic images of cheques. This “dematerialisation” or “digitisation” (depending on your preferred jargon) of the whole cheque process will bring significant benefits to all participants.
• Cheque Clearing times can come down from its current range of up to 6 days to a next day process (i.e. you pay a cheque in on a Monday; you get full committed access to funds by close of play Tuesday).
• It removes considerable cost from the industry in terms of courier and van transportation costs.
• It creates opportunities for customers to lodge cheques without visiting a branch; e.g. a personal customer taking a photo of a cheque via their banking app on their mobile or corporate customers scanning the cheque images in their corporate headquarters.
Cheques are the oldest payment instrument after coin and cheque processing is deeply embedded in the big banks’ systems and processes in ways that mean cheque change translates to substantial IT and operational change. Some examples of the changes required are;
• The banks have evolved credit decision processes for cheques into a multi-day batch process which is coupled with the processing of batches of direct debits, standing orders and future dated payments. This was feasible because of the multi day cycles associated with cheques. All the Pay/No Pay decisions and credit processes will have to be radically re-engineered to cope with the next day timescales.
• The dematerialisation of the cheques means that they effectively become another electronic payment message type which will have to integrate into the banks’ payment handling architectures.
• The core Banking systems have developed a range of capabilities over the years to cope with cheques; for example crediting an account for interest after two days but not crediting the account for available funds until after four days. Some banks offer different levels of availability for interest/funds depending on whether the customer paying in the cheque is in the same branch/bank as the customer where the cheque is paid out from. Some banks also vary their availability depending on the riskiness of the customer. All these interest and funds calculation processes will need to be re-written in line with a next day cycle.
• A number of product propositions will need to be reviewed and changed such as the Head Office Collection Account (HOCA) and Agency Bank propositions. These will involve changes to the payments and Core Banking systems.
• There is plan to be a period of about 6 months “parallel running” of both paper based clearing and the new image based approach. This will further complicate all the previous points as it means that a new model cannot replace a previous model but will have to work alongside it with complex hybrid business processes being needed.
Overview Of PSDII
The Payment Services Directive has a number of requirements but the key requirements are;
• The ability to provide an application programming interface “API” into the Bank’s payment systems to allow authorised third party payment services providers to generate payments instructions off the customers’ accounts.
• The ability to provide an “API” into the bank’s core banking systems to allow authorised third parties to request account information from a customer’s bank. (The aim being to help other organisations provide new or better services; e.g. comparison sights, credit providers; shopping advising, etc).
This will provide challenges to banks in two main ways. The first is to be able to develop and implement robust API’s that are open; this against legacy banking platforms that are not in the least bit architected for open service orientation.
The second is to come up with security models that manage the conflicts between open access, AML constraints, Data Protection and banking confidentiality and then operationalise these.
The collective impact of these three regulatory changes means that, in the opinion of HBW, something will have to give. We do not believe the main banks will be able to support all these changes in the same two-year timescale.
There are not enough;
• Core Banking and Payments key skills.
• Available test slots/test environments and implementation and proving weekends for all this to happen.
Given the Future Clearing Model requires all banks to be ready at the same time; it can only go as fast as the slowest bank. Thus it seems to HBW that banks will end up implementing ICB, PSD and delaying the introduction of cheque imaging.